Commercial real estate is in trouble. Why you should be paying attention
A version of this story first appeared in CNN Business’ Before the Bell newsletter. Not a subscriber? You can sign up right here. You can listen to an audio version of the newsletter by clicking the same link.
Economists are growing concerned about the $20 trillion commercial real estate (CRE) industry.
After decades of thriving growth bolstered by low interest rates and easy credit, commercial real estate has hit a wall.
Office and retail property valuations have been falling since the pandemic brought about lower occupancy rates and changes in where people work and how they shop. The Fed’s efforts to fight inflation by raising interest rates have also hurt the credit-dependent industry.
Recent banking stress will likely add to those woes. Lending to commercial real estate developers and managers largely comes from small and mid-sized banks, where the pressure on liquidity has been most severe. About 80% of all bank loans for commercial properties come from regional banks, according to Goldman Sachs economists.
“I do think you will see banks pull back on commercial real estate commitments more rapidly in a world [where] they’re more focused on liquidity,” wrote Goldman Sachs Research’s Richard Ramsden in a note on Friday. “And I do think that is going to be something that will be important to watch over the coming months and quarters.”
Recently, short-sellers have stepped up their bets against commercial landlords, indicating that they think the market will continue to fall as regional banks limit access to credit. Real estate is the most shorted industry globally and the third most in the United States, according to S&P Global.
So just how big of a deal is this threat to the economy? Before the Bell spoke with Xander Snyder, senior commercial real estate economist at First American, to find out.
This interview has been edited for clarity and length.
Before the Bell: Why should retail investors pay attention to what’s going on in commercial real estate right now?
Xander Snyder: Banks have a lot of exposure to commercial real estate. That impacts banking stability. So the health of the market has an impact on the larger economy, even if you’re not interested in commercial real estate for commercial real estate’s sake.
How bad are things right now?
Price growth is slowing and for some asset classes it’s starting to decline. Office properties have been more challenged than others for obvious reasons.
Now private lending to the industry is starting to slow as well — bank lending was beginning to dry up over a month before the Silicon Valley Bank failure even happened. Credit was getting scarce for all commercial real estate and a fresh bank failure on top of that only exacerbates that trend.
How do you expect banking turmoil to make things worse?
I think more regulatory scrutiny is coming for smaller banks, which tend to have a larger concentration of commercial real estate loans. That means small and medium-sized banks are going to tighten lending standards even more, making it more difficult to get loans.
Does the possibility of a looming recession play into this?
As credit becomes scarcer and more expensive, it’s hard to know exactly what buildings are worth. You get this gap opening up between sellers and buyers: Sellers want to get late 2021 prices and buyers are saying ‘we don’t know what things are worth so we’ll give you this lowball offer.’ That was already happening and the result of that price differential was bringing deal activity down.
There’s no broad agreement on asset valuations. Economic uncertainty will exacerbate that trend. And if you’re a bank, it’s a lot more difficult to lend against the value of a building if you don’t know what the value of the building really is.
So how worried should we be?
A lot of people hear commercial real estate and they think it’s all the same thing and the trends are they’re all the same but they’re not. The underlying fundamentals of multifamily and industrial assets remain relatively stable on a national level.
It’s different for office and retail properties. There’s been a fundamental shift in how we use office space and that has changed demand. That’s something you should have your eye on, especially as low-interest office loans come due. We’re running into a situation where office-owners have to refinance at a higher rate and only 50% of the building is being used. That doesn’t translate to good cash flow metrics for the lender.
I think retail also faces challenges. A lot of people are still sitting on excess pandemic savings that are beginning to be spent down and the Fed is certainly trying to nudge unemployment up a little bit. So I imagine that both of those things will impact retail spending and therefore impact retail as an asset class.
Economists forecast recession and elevated inflation
Stagflation, the combination of high inflation and a weakening economy, could make a comeback. The majority of economists expect a recession sometime this year and forecast that inflation will remain above 4%, according to The National Association for Business Economics’ latest survey, released Monday.
It appears as though the fog has lifted since last month’s survey, which showed a significant divergence among respondents about where they think the US economy is heading in 2023.
“Panelists generally agree on the outlook for inflation and the consequences of rate hikes from the Federal Reserve,” said NABE Policy Survey Chair Mervin Jebaraj. “More than seven in ten panelists believe that growth in the consumer price index (CPI) will remain above 4% through the end of 2023, and more than two-thirds are not confident that the Fed will be able to bring inflation down to its 2% goal within the next two years without inducing a recession.”
Still, more than half of NABE Policy Survey panelists expect a recession at some point in 2023. But only 5% believe the United States is currently in one. That’s nearly four times lower than the 19% who believed the US was in a recession in August.
Banking turmoil brings us ‘closer right now’ to recession: Fed President Kashkari
The recent meltdown in the banking industry could tip the US into recession said Federal Reserve Bank of Minneapolis President Neel Kashkari.
“It definitely brings us closer right now,” he said during a CBS Face the Nation interview this weekend.
“What’s unclear for us is how much of these banking stresses are leading to a widespread credit crunch. And then that credit crunch, just as you said, would then slow down the economy,” he added.
While Kashkari said that the financial system is “resilient” and “strong” he said that there are still “fundamental issues, regulatory issues facing our banking system.”
Calgary home sales reach new May record: real estate board – CBC.ca
The Calgary Real Estate Board says the market hit a new May record for sales as the number of properties that changed hands reached 3,120 last month.
The board says the sales amount to an almost two-per-cent increase from last May, when sales totalled 3,063.
Despite the record, year-to-date sales are still almost 30 per cent behind where they were last May and the board says the market has still not shifted completely away from the declines seen at the start of the year.
The board says it continues to see fewer new listings than last year, with the number of properties listed on the market last month dropping 15 per cent to 3,652.
The market’s benchmark price was up almost three per cent at $557,000, while the average price pushed up roughly six per cent to $551,853.
The board’s chief economist says the numbers reflect a higher interest rate environment and recent rental rate gains, which are driving more people to seek apartment and condo units.
Recreational homes: What to know about inheriting a cottage – CTV News
With a high number of Canadians expected to retire over the next few years, the trend of younger generations inheriting their family cottages will contribute to “major shifts” in the ownership of recreational homes, according to new research from Re/Max.
But amid rising concerns around the cost of housing, some may be wondering whether they can afford to keep their recreational home in the family.
In its 2023 Cottage Trends Report released April 27, Re/Max says Generation X is already driving the recreational housing market, partly due to the high volume of intergenerational wealth transfers. Additionally, data released by TD Bank Group earlier this year shows nearly 900,000 baby boomers are set to retire within the next three years.
According to Christopher Alexander, president of Re/Max Canada, many more families are likely to pass their cottages down to loved ones in the years to come.
“The torch has kind of been passed from baby boomers to gen-Xers, who are driving market activity right now,” Alexander told CTVNews.ca in a telephone interview on Wednesday. “[Gen Xers] are also buying cottages with the intention to pass it on to their children [and] have it as a family heirloom.”
A Leger survey commissioned on behalf of Re/Max as part of its trends report shows 56 per cent of Canadians either plan to or have already put their recreational property in their beneficiary’s name. Additionally, 74 per cent of those who own recreational properties say they feel confident they will be able to pass down their property to relatives with the proper planning.
While many Canadians appear confident in their ability to do this, a key factor to take into consideration is whether their children can afford to keep the home, said Jamie Golombek, managing director of tax and estate planning with CIBC in Toronto.
Amid a cost-of-living crisis, home affordability remains a concern for many. Canada has the highest level of household debt in the G7, a volume that has been growing “inexorably” because of rising home prices, according to the Canada Mortgage and Housing Corporation.
It’s not uncommon for families to sell a cottage to absolve themselves of ownership, Alexander said. More often than not, this isn’t because relatives have lost interest in owning the home, but because of the hurdles they confront while trying to keep it, said Peter Lillico, a lawyer with Lillico Bazuk Galloway Halka based in Peterborough, Ont.
“Parents make assumptions like, ‘the kids love the cottage and they get along, therefore there’s a cottage succession plan,’ and it’s just not,” he told CTVNews.ca in a telephone interview Thursday. “One of the main reasons that those cottages go up for sale after decades is you’ve got three kids and one of them says, ‘I can’t afford it.’”
Looking specifically at the recreational housing market, average prices remain above pre-pandemic levels today, Alexander said. Combined with elevated interest rates, “the ability to carry two properties has been more challenging in the last year,” he said.
ARE THERE TAXES INVOLVED IN INHERITING A COTTAGE?
In addition to keeping up with property taxes and mortgage costs, families will need to factor in a capital gains tax when transferring ownership of their cottage, said Lillico.
Whether parents are selling their recreational home to their children or giving it as a gift, the transfer is still considered a “disposition” by the Canada Revenue Agency, or a sale at fair market value, Lillico said. This will trigger a capital gains tax, which is a federal levy that accounts for the increase in a home’s value since it was last purchased.
In Canada, 50 per cent of the capital gain from a sale must be added to the seller’s total taxable income. The amount they will pay is based on their tax bracket. If the homeowners die before transferring ownership, this tax can be paid using money from their estate, Lillico said.
A principal residence tax exemption can allow homeowners to avoid paying a capital gains tax on profits made from selling a property if it’s their main residence. But any profit generated up until the home is designated a principal residence is still taxable, said Lillico, who has more than 44 years of experience in cottage succession planning.
“The cottage may qualify as their principal residence from that point forward, but it doesn’t wipe out capital gains [from previous years],” he told CTVNews.ca. “Sometimes that will catch people by surprise.”
One way to temporarily avoid paying capital gains taxes is to place the home in a “sprinkling” cottage trust, Lillico said, a type of asset protection trust. This will allow the next generation to transfer the recreational property to their children without paying a capital gains tax for up to 21 years. Placing the property in this kind of trust will also protect the owners from third-party claims if someone were to get divorced or go bankrupt.
Being mindful of insurance fees and other costs involved in maintaining the home will help families make an informed decision on whether the next generation can afford to keep the property, or if they should sell it, Alexander said.
Golombek also recommends speaking with financial advisers to determine the tax consequences of inheriting a family cottage, as well as whether a person’s income and expenses will allow them to afford to keep it.
FAMILY DYNAMICS ANOTHER IMPORTANT CONSIDERATION: EXPERTS
In addition to finances, it’s important that parents speak with their children about whether they want to inherit the recreational home in the first place, said Golombek.
“Especially if there’s multiple kids … it’s very important to have that discussion,” he told CTVNews.ca in a telephone interview Thursday. “If they don’t all want it, then you can create a lot of issues there by leaving it to them equally.”
Lillico recommends creating a legally enforceable cottage sharing agreement for those who will inherit the property before it is passed down. In writing, family members should lay out terms around access to the property, the sharing of expenses and any restrictions on transferring the home to those outside the family. He also suggests setting money aside, if possible, to cover repair costs down the road.
THE STATE OF CANADA’S RECREATIONAL REAL ESTATE MARKET
Most of Canada has seen a rise in the supply of recreational homes, aside from some outliers in Ontario and British Columbia, where prices are “exorbitant,” Alexander said.
Areas such as Muskoka and Prince Edward County in Ontario have seen property values go through the roof over the last few years, leading many recreational homeowners in these regions to see high capital gains over time, he said. As these markets remain hot, peripheral regions such as those further north in the province have become more attractive as cheaper alternatives.
“Within three hours of a major city, as long as the demand is there … you’re going to see property values increase and then you’ll have higher capital gains,” Alexander said.
CTVNews.ca has put together a list of recreational properties currently on the market across Canada.
(Hayden Simon, Century 21 Creekside Realty)
Location: Harrison Hot Springs, B.C.
Year Built: 2002
Property Size: 189.52 sq. m
Lot Size: 0.33 hectares
Situated on the shores of Harrison Lake, this leasehold property is a two-hour drive from Vancouver. With nearly 190 square metres of living space, it includes five bedrooms and two bathrooms. The home also features a wood stove in the living area and a wood-burning hot tub in the backyard.
(Ryan Sagert, 1.m.A Media / Cathren Dorchester, Royal LePage Parkland Agencies)
Location: Rural Wetaskiwin County, Alta.
Year Built: 1980
Property Size: 78.42 sq. m
Lot Size: 0.08 hectares
This lakefront home has four bedrooms and two bathrooms, in addition to a kitchen, living room and fully finished basement. The lower level comes with heated floors and offers outdoor access. In the backyard is a fire pit, along with a stone walkway that leads to Pigeon Lake.
(Big Bay Media / Erin Monett, Chestnut Park Real Estate)
Location: Muskoka, Ont.
Year Built: 1976
Property Size: 165.55 sq. m
Lot Size: 1.31 hectares
Two separate docks lead the way to this four-bedroom, two-bathroom home in Muskoka, Ont. The property includes nearly 314 metres of shoreline along Green Bay, and 1.31 hectares of land. Large windows in the dining area provide a clear view of the waterfront. In addition to the cottage, a seasonal log cabin is also situated on the property.
(Carol Love, Century 21 Lanthorn Real Estate)
Location: Prince Edward County, Ont.
Year Built: 1981
Property Size: 130.06 sq. m
Lot Size: 1.09 hectares
Located in Prince Edward County, Ont., this waterfront bungalow offers views of Consecon Lake. Inside the home are four bedrooms, two bathrooms, a living room, kitchen and recreation room. In the backyard is a screened porch and deck facing the water, which can be accessed via a private boardwalk. This recreational home is located near Millennium Trail as well as shops, wineries and more.
(Christopher Green / Joel Flewelling, Royal LePage Atlantic)
Location: Annapolis County, N.S.
Year Built: 1882
Property Size: 118.73 sq. m
Lot Size: 0.25 hectares
This two-storey home has two bedrooms, two bathrooms and nearly 120 square metres of living space. On the main floor is a combined living and dining area with a wood-burning stove, as well as a sunroom. On the upper floor, both bedrooms share a full bathroom, which includes a shower.
PRINCE EDWARD ISLAND
(Odyssey Virtual / Jodi Bernard, Century 21 Northumberland Realty)
Location: Queens County, P.E.I.
Year Built: 2019
Property Size: 142.7 sq. m
Lot Size: 0.4 to 1.2 hectares
Situated on top of a hill, this cottage in central P.E.I. offers panoramic views stretching from Sea View to Park Corner. It features two bedrooms and two bathrooms, along with a kitchen and combined living and dining area. At the back of the home is a covered deck that is partially screened-in.
NEWFOUNDLAND AND LABRADOR
(Krista Trask, Century 21 Seller’s Choice)
Location: Whitbourne, N.L.
Year Built: 2020
Property Size: 228.91 sq. m
Lot Size: under 0.4 hectares
Modern finishes can be found throughout this home in Whitbourne, N.L. The open-concept layout of the main floor includes vaulted ceilings and chalet windows. Also on the main level is a gourmet kitchen with an island that can seat three people. The main bedroom has a private patio door with access to the front deck, as well as three-piece ensuite.
Victoria real estate sales up and prices down year-over-year – Times Colonist
Real estate prices picked up slightly in May from April, but remain below levels seen a year ago in the capital region.
The number of properties that changed hands climbed by 22 per cent in May from the previous month, indicating increased consumer confidence, Victoria Real Estate Board chair Graden Sol said Thursday, when monthly data was released.
May saw the highest number of sales since April of last year, he said.
While sale numbers lag below what would typically be expected in a spring market, May was the fourth consecutive month with sales higher than the previous month’s.
A total of 775 properties, valued at $774.9 million, sold through the board last month.
That represents an increase of 1.8 per cent from May 2022 and 21.7 per cent from April of this year, the board said.
The benchmark price for a single-family house in Victoria’s core was $1.297 million last month, a drop from $1.4 million in the same month a year ago.
Last month’s benchmark price was $1.295.8 million.
The benchmark price for condominiums in Victoria’s core slid to $569,300 in May from $619,500 a year earlier, although it was up slightly from April, when it was $564,000.
A total of 2,189 properties were for sale at the end of May, up 7.1 per cent from April, and up 23.3 per cent from the end of May last year.
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